What Type of Coverage Should Be Written In a Captive?

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Low frequency/low severity risks- Sometimes it doesn’t make sense to carry traditional insurance for claims that rarely occur and even when they do occur they are always of low-severity. Traditional insurance might not be available or it may be expensive since the carriers may charge a minimum amount for the coverage. In this case, an appropriate captive policy can balance the need for coverage and the need for appropriate premium pricing based on the individual organization’s risk profile.

High-frequency/low severity risks- Some companies experience a high number of low-severity (or low-cost) claims. Purchasing insurance coverage in the traditional market for this type of claim can be expensive because of the high-frequency nature of the loss history. A captive can make appropriate adjustments thereby reducing the overall cost of financing the risk.

Low-frequency/high severity risks coupled with a stop-loss strategy- When claims related to a particular risk occur very infrequently but the potential loss is severe, companies often find themselves paying very high premiums for events that rarely if ever occur. For those companies who have programs or procedures in place to reduce or eliminate the risk of such claims and who wish to reduce the cost of financing whatever underlying risk actually exists, a captive is often a good alternative. This works, however, only when there is a sound stop-loss strategy in place to ensure that if a severe claim does occur, there is appropriate excess coverage to handle it.

Risks with large established claims data and existing market of reinsurers- Most captives rely on reinsurance to handle much of the risk shifting. When there is an existing strong market for the reinsurance sought and there is well-established claims data, there is a good chance that the reinsurance will be very competitively priced and easy to secure. In this case, there is a good chance the overall program to underwrite these risks using a captive will be more financially attractive to the insured than simply buying traditional insurance.

Risks where premiums to policy limits are very close- If you are purchasing coverage from a traditional carrier and the premiums you are paying are not too different than your policy limits, you would likely benefit from having the captive underwrite that risk. First, the captive coverage will be less expensive because even for the same policy, the captive’s overhead is much lower than the traditional carrier. Second, you are getting almost no benefit from the traditional insurance if you are paying out about as much as you would hope to get back in the event of a loss. You are much better off paying the premium to yourself (i.e., to your captive) taking the deduction and then investing the money according to your captive’s investment policy.

Risks that the company manages better than those in its industry- When your company has figured out a way to manage risk significantly better than others in your industry, writing coverage for that risk through a captive should be a consideration.

Currently self-insured risks- There are risks your company is currently self insuring. Some of these risks are obvious to you; for example, you may decide that for certain risks where you have a history of frequent, small claims, you’d rather pay the claims directly instead of relying on insurance coverage. However, because you want to make sure you are covered in the event one of those small claims becomes a very large claim, you keep traditional coverage but maintain a high deductible. So, effectively, you are self-insuring your claims up to a certain “retention” level. You may even have excess or catastrophic coverage that goes beyond that initial policy limit.